A 409A valuation is an independent appraisal of what one share of a private company's common stock is worth — the fair market value that sets the strike price of every employee stock option the company issues. It is named for Section 409A of the U.S. tax code, whose penalties for mispriced options are severe: options struck below fair market value trigger immediate income recognition plus a 20 percent penalty tax for the holder. The mechanics are procedural, but the consequences reach every employee's equity, and founders who misunderstand what the number is for — which is tax safety, not pride — make expensive mistakes. Honey Badgers publishes information, not tax or legal advice.
How is a 409A actually produced?
An independent valuation firm — a specialist shop or an accounting firm — models the company from its own data: financials, projections, comparable public companies, and the terms of the latest preferred round. The standard methods: the market approach (revenue or earnings multiples from comparable public companies, discounted heavily for being private and small), the income approach (a discounted cash flow on the company's own projections, haircut by the probability the projections are fiction), and — the decisive piece — the option pricing model and backsolve: working backward from what investors just paid for preferred shares, subtracting the preferences those investors hold, to derive what common is worth after the preferred stack eats first. The output lands predictably: 409A values commonly sit at roughly 20 to 40 percent of the last round's post-money per-share price, with earlier-stage companies showing wider gaps.
Why is it always lower than the round price?
Because preferred and common are different instruments. Investors paid the round price for preferred stock carrying liquidation preferences, anti-dilution rights, and control terms; common stock sits last in the exit waterfall and votes last in governance. The discount is the measured value of those differences plus illiquidity — common shares in a private company cannot be sold. The discount is not pessimism about the company; it is the arithmetic of the stack. Employees should internalize the corollary: the strike is set low relative to the preferred price precisely so options have value at the bottom of the exit range, which is also where the preference stack does its damage.
When does a company need a new 409A?
The safe-harbor rules let a valuation stand for up to 12 months, but material events reset the clock: a new priced round, an acquisition offer, a material change in projections or business condition. The documented practical rhythm: a fresh 409A after every round, occasionally intra-round when something material happens — a big contract, a product failure, a market repricing. In down markets the resets cut both ways: post-2022, hundreds of companies took lower 409As, which was good news for new option grants — lower strikes — and irrelevant-to-painful for existing grants struck at 2021 prices, now underwater. The 'cheap' strike of a down-market 409A is one of the few documented silver linings of a repriced company.
What should founders know about running the process?
Four practical notes from practice. Timing: commission the 409A immediately after a round closes — the firm prices from the round documents while they are fresh, and option grants wait on it. Choice of firm: the report's defensibility is the product; a discounter's report invites IRS challenge, and the fee difference is trivial against the penalty exposure. Projections discipline: the income approach runs on management's own forecasts, and heroic projections produce higher 409As that look flattering right up until they make every option grant riskier. And board hygiene: the 409A is evidence the board exercised fiduciary care in setting strikes — the grant-date discipline matters as much as the number.
What should employees understand about it?
The 409A is the strike, not the dream: the value of an option is what the exit price does above the strike, and both the strike (set by 409A) and the exit waterfall (governed by preferences) are printed in documents employees are entitled to ask about. The two questions worth asking in any offer: what is the current 409A strike, and what is the total preference stack over common. A company that answers both cleanly is doing equity right; a company that cannot produce the first number is not issuing options lawfully, and one that will not discuss the second is hiding the arithmetic that decides whether the options pay.
The 409A is the startup's most honest number — conservative by statute, backward-looking by method, and deliberately unglamorous. Founders should treat it as plumbing; employees should treat it as the floor of their equity math; and everyone should remember that the headline valuation and the 409A measure different things on purpose.
For more context, read How a Down Round Reset Klarna From $45.6B to $6.7B.
For more context, read liquidation preference.
For more context, read Secondaries: How Employees Sell Shares Before an IPO.